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When Government Spying Shorts Investors

Cisco shares took a tumble in response to disastrous international results. Where does espionage come into the story?

When selling anything, it's important to avoid any hesitating and get the customer to sign on and commit to a purchase as quickly as possible. If too much time elapses, more doubts can creep in. On the other hand, if the customer commits early on, their own cognitive biases can secure the sale -- and future business.

So, when the president of sales states that something is "certainly causing people to stop and then rethink decisions," it can definitely hurt business in a magnified manner for both current and future sales. And this is exactly what Cisco's (NASDAQ:CSCO) executive said concerning the revelations about the National Security Agency's spying around the world.

What was the quantified effect of the NSA's activity on Cisco's sales? And what can investors do about it?

Emerging market reversalIn the conference call, CEO John Chambers specifically noted that spying tensions affected sales in China, while describing the total effect across its emerging business as "fairly nominal." Even so, while the quarter ending in April saw an 8% rise in orders from developing countries, the most recent results recorded a 21% decline. China, Mexico, and India orders fell 18%, Brazil orders fell 25%, and Russia orders fell 30%.

The other reason discussed for such a drop off pointed to "inconsistent data" from "macro driven" issues. The percentage of sales from abroad remained similar to previous quarters -- around 40% of total revenue -- with overseas revenue totaling $4.8 billion of Cisco's $12.1 billion in sales for the last quarter.

It's impossible to attribute either reason to a certain value of lost profit. But if we take analyst expectations of $12.3 billion in revenue compared to the actual $12.1 billion reported, the $200 million gap is a good ballpark number to begin with. That $200 million gap also pops up in the difference in revenue from the Asia-Pacific, Japan, and China region from the same quarter last year. And with Chambers' comments specifically mentioning "challenging political dynamics" in China, the failure to keep revenue level in that region might very well be attributed to a lack of trust due to U.S. intelligence agencies.

With Cisco's net margin of 16.5% for the quarter, that missing $200 million in revenue is $33 million in profit. And this doesn't count the potential future losses, which are seemingly large from Cisco's future guidance to "model revenue conservatively." The fallout from these politics could add up.

Investing around the issuesPolitical situations can always cause unexpected shocks to a company's value, and introduce a level of uncertainty that the market may fail to price in before these shocks are reported in an earnings statement. Sometimes such events can boost a company's prospects. Take Sturm, Ruger, which has recently had to deal with the prospect of stricter gun control since late 2012. As CEO Michael Fifer stated, a "spike in demand started in the fourth quarter of 2012, remained unusually strong through the second quarter of 2013 and is now finally settling down to more historical levels." Consumers felt they had to buy before new legislation, and gun companies got a quick boost in sales.

But how should an investor approach potentially value-destructing political situations? Like any other business risk: Attempt to put a price on just how destructive a certain outcome could be for a company and how much value a company could lose from it. For Cisco, while the market chopped off roughly $20 billion in market capitalization after its earnings report, it's unlikely it will have to deal with much worse political consequences -- especially since the company has managed future expectations. Given this, it still has solid footing in the infrastructure that powers the Internet.

The costs of politicsThe relationship between the U.S. and China is mostly outside the power of Cisco, even though it's likely that it cost the company a healthy chunk of revenue. Now, Cisco needs a reaction that will stem future losses, and its acknowledgement of the issues and guidance for a tough future are honest first steps.